Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow $10,000,000 fixed for 5 years.Their external borrowing opportunities are shown below: A swap bank proposes the following interest only swap: Y will pay the swap bank annual payments on $10,000,000 with a fixed rate of 9.90%.In exchange the swap bank will pay to company Y interest payments on $10,000,000 at LIBOR - 0.15%; What is the value of this swap to company Y?
A)Company Y will save 15 basis points per year on $10,000,000 = $15,000 per year.
B)Company Y will save 45 basis points per year on $10,000,000 = $45,000 per year.
C)Company Y will save 5 basis points per year on $10,000,000 = $5,000 per year.
D)Company Y will only break even on the deal.

Question

Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow $10,000,000 fixed for 5 years.Their external borrowing opportunities are shown below:  A swap bank proposes the following interest only swap: Y will pay the swap bank annual payments on $10,000,000 with a fixed rate of 9.90%.In exchange the swap bank will pay to company Y interest payments on $10,000,000 at LIBOR - 0.15%; What is the value of this swap to company Y?
A)Company Y will save 15 basis points per year on $10,000,000 = $15,000 per year. 
B)Company Y will save 45 basis points per year on $10,000,000 = $45,000 per year. 
C)Company Y will save 5 basis points per year on $10,000,000 = $5,000 per year. 
D)Company Y will only break even on the deal.

Quizplus · Accepted Answer

Company Y wants to borrow $10,000,000 fixed for 5 years at a rate of 5.25%, which translates to an annual payment of $525,000. The swap bank is offering a fixed rate of 9.90% for the same amount, which translates to an annual payment of $990,000 for company Y. In exchange, the swap bank will pay company Y interest payments on $10,000,000 at LIBOR - 0.15%.

Assuming LIBOR is at 1.20%, then the interest payment from the swap bank would be 1.20% - 0.15% = 1.05%, which translates to an annual payment of $105,000. Therefore, the net annual payment from company Y to the swap bank would be $990,000 - $105,000 = $885,000.

If company Y had borrowed $10,000,000 at LIBOR + 0.30% (which is the external borrowing opportunity), they would have paid an annual interest of $10,000,000 x (1.20% + 0.30%) = $1230,000. This translates to a savings of $345,000 per year by entering into the swap agreement with the swap bank.

Thus, Company Y will save 45 basis points per year on $10,000,000 = $45,000 per year.

Company X Wants to Borrow $10,000,000 Floating for 5 Years;